You are contemplating investing into two different projects. Both projects are o

Question

You are contemplating investing into two different projects. Both projects are of equally low risk and their cash flows are provided below. a. Determine the NPV of each project at a 6% cost of capital. Which is preferable? b. Based on the profitability index, which would you prefer? c. At what discount rate would you be indifferent between the projects (i.e., calculate the crossover rate)? d. Graphically illustrate what an NPV Profile Chart would look like (generally) if a crossover rate exists? Include the crossover rate calculated (step c), the NPV’s from (step a) and other appropriate labels for the axes, and project plots, etc.

Year

Project “Gold”

Project “Blue”

0

-$50,000

-$25,000

1

$22,500

$3,000

2

$18,750

$6,000

3

$15,250

$12,000

4

$15,000

$24,000

Year

Project “Gold”

Project “Blue”

0

-$50,000

-$25,000

1

$22,500

$3,000

2

$18,750

$6,000

3

$15,250

$12,000

4

$15,000

$24,000

Explanation / Answer

Solution:

C Indifference point is that point, where NPV of both the projects is equal.

So, In the given case this point is 7.75%

At this level NPV of both the Project is equal.

That is 10348

Project Gold Year 0 Year 1 Year 2 Year 3 Year 4 Initial Investment -50,000 Cash flows 22,500 18,750 15,250 15,000 Present value of $ 1 @ 6 % 0.943 0.890 0.840 0.792 Present value of cashflows         21,226.42            16,687.43         12,804.19    11,881.40 Total present value of cashflows                                                                                                                              62,599.45 NPV = Total present value of Cashflows - Initial Investment                                                                                                                              12,599.45 Project Blue Year 0 Year 1 Year 2 Year 3 Year 4 Initial Investment -25,000 Cash flows 3,000 6,000 12,000 24,000 Present value of $ 1 @ 6 % 0.943 0.890 0.840 0.792 Present value of cashflows           2,830.19               5,339.98         10,075.43    19,010.25 Total present value of cashflows                                                                                                                              37,255.85 NPV = Total present value of Cashflows - Initial Investment                                                                                                                              12,255.85 According to the creteria of NPV, Project Gold id preferrable as it has more NPV

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.